Ever wonder why the rich seem to only get richer? While there may be a number of factors at play, an oft-overlooked difference between Wall Street and Main Street is the ability not only to earn more money but also to keep more money by avoiding taxes.
The good news? Tax avoidance is not limited to the rich. With a little research and hustle, you can copy their tactics and take advantage of the same tax rules that allow the rich to hold on to more of their money.
An Important Caveat
Before we dive in, it’s important to make one distinction clear. All of the strategies discussed in this article are aimed at tax avoidance, which is the act of reducing one’s tax burden within the confines of tax laws. This is in contrast to tax evasion, which involves misrepresenting one’s financial status in order to pay less tax.
While tax avoidance is perfectly legal—it is used by accountants and tax professionals—tax evasion is a felony that can result in fines and/or prison time.
Now, taking a cue from some of the best-known names in wealth, here are five strategies to (not) pay taxes like the rich.
1. Invest like Warren Buffett
Billionaire Warren Buffett paid only 17.4 percent of his income in tax in 2011—a far smaller percentage than the rest of the people in his office, who paid between 33 percent and 41 percent. How is that possible? Buffett makes comparatively little money as income and almost all of his money as capital gains, which are the increase in value of an asset such as real estate or shares of stock. Tax rates for long-term (more than one year) capital gains are far lower than the tax rates for income at comparable levels, sometimes as low as 15 percent.
The Everyman Solution: Invest. You don’t have to quit your job for Wall Street, but it’s smart to put your money to work for you in a low-tax vehicle such as a 401(k) or Roth IRA. But remember: Investing can be challenging, so take it slow—start with a small amount and see where it takes you.
2. Spend like Mitt Romney
This might sound counterintuitive, but spending money can help you reduce your taxes. When he was running for president in 2008, Mitt Romney spent $45 million of his own money on his campaign. This took a chunk out of his net worth, thereby lowering his tax burden. In effect, he spent money to save money—and took a shot at the White House in the process.
The Everyman Solution: Recognize that tax savings can sometimes soften the cost of required expenses. Whether it’s deducting your mortgage-interest payment or reducing your estate before your death, taking advantage of certain tax rules can reduce the effective cost of expenses you would have paid anyway.
3. Give your wealth to family like Nike CEO Phil Knight
Assets such as stocks and real estate carry benefits that make them especially advantageous from a tax perspective. Assets can be passed on to family members with little to no tax implication. For example, there is no limit on tax-free bequests to a spouse upon your death. You may also transfer asset value to children and other heirs through vehicles such as charitable trusts, which reduces tax liability. Phil Knight’s recent $400 million contribution to a trust is likely to significantly reduce the taxes owed by its beneficiaries.
The Everyman Solution: Trusts are by no means limited to the rich. Keep in mind, however, that the first $5.25 million of inheritance is excluded from estate tax, so special financial vehicles may not be required to pass on your legacy.
4. Take advantage of corporation-only tax benefits like Apple
Corporations are subject to different tax laws than individuals. For example, Apple has for the past few years paid a corporate tax rate of 2 percent or less. How exactly did Apple achieve this feat? Through a clever method involving international tax-residency laws.
U.S. law states that any company established in the United States is a U.S. tax resident. Irish law, on the other hand, states that any company that is managed or controlled in Ireland is an Irish tax resident. So Apple devised a way to be established in Ireland but to control and manage operations from the U.S., thereby avoiding tax residency in either country.
The Everyman Solution: Small-business owners and individual contractors can often take advantage of special tax laws for corporations. For example, tax rates on corporate earnings are generally lower than personal-income rates, and business-related expenses can be written off. In addition, keep an eye on the differences between U.S. law and laws in other nations. Finding a loophole can help you save a substantial amount of money through completely legal means.
5. Give it away like Bill Gates
The final, and most philanthropic, way to avoid taxes is by giving your money away. If you itemize your taxes, the donations you make to nonprofit organizations are tax-deductible, meaning the amount you donate directly reduces your adjusted gross income (up to IRS-specified limits).
The Everyman Solution: Give back. Donations are tax-deductible, and they carry the additional incentive of giving you the warm fuzzies. Keep in mind that you’ll need to itemize your deductions to take advantage of write-offs for charitable giving, and that receipts are required to prove you actually donated what you claim. In many cases, taking the standard deduction is a better deal than itemizing, so be sure to do your calculations.
There you have it: five simple and perfectly legal ways to reduce your tax burden. While we might differ from the super-rich in the number of zeros at the end our paycheck, we can all take advantage of the same opportunities—so long as we’re willing to be creative.
Of course, not every method will fit every household or individual. If you’d like to learn more, check out NerdWallet’s Ask an Advisor for free answers to your tax questions from financial professionals.
Have any other tips or methods for (not) paying taxes like the rich? Let us know in the comments.